Sustainability has become one of the defining megatrends affecting businesses worldwide, and the merger & acquisition (M&A) world is no exception. According to KPMG 2022 EMA ESG Due Diligence Study, more dealmakers are starting to be influenced by sustainability linked criteria. Targets with strong sustainability stories are enjoying price premiums, and M&A teams are increasingly conducting Environmental, Social and Governance (ESG) Due Diligence (DD) on targets at the early stage of their assessments.

The study surveyed 150 dealmakers across Europe, the Middle East and Africa. They were asked about what works and what doesn’t, and what challenges they face going forward. Various models for embedding ESG into DD were also discussed. The results showed little consensus around what ESG DD means. Dealmakers are divided about how best to incorporate ESG DD into their existing due diligence frameworks. ESG DD work is often underfunded. And ESG DD is not always aligned to the organization’s overall ESG strategy.

Nicolas Ribollet, Partner & Head of Deal Advisory at KPMG in Bahrain, commented on the report findings and said:” Dealmakers are divided about how best to incorporate ESG DD into their existing due diligence frameworks. Based on my experience, they need to start establishing links to the company’s overall sustainability strategy. The next step would be to develop blueprint for ESG DD, both in terms of its intellectual framework, as well as from an organizational perspective. Before implementing those plans, dealmakers need to ensure the corresponding budget and capabilities to ensure ESG DD delivers on the corporate ESG strategy.”

Study key findings:

Something exciting is happening at the nexus of M&A and ESG. Dealmakers are actively integrating ESG considerations into their deal activities. Investors across the board are ramping up their ESG due diligence efforts. And premiums are being paid for targets that meet ESG priorities. Dealmakers see the financial value and potential uplift opportunities that can be achieved by understanding a target’s ESG-related performance at an early stage of the transaction process.

However, there are still major challenges faced by ESG DD practitioners. Specifically, there appears to be no market consensus around what a standard ESG DD scope would include, as practitioners struggle with the breadth of the term “ESG”. And targets aren’t always able to provide quality data or documentation. As such, practitioners can often struggle to quantify their findings and related financial impacts or value creation opportunities.

Nonetheless, there are clear indications of “what good looks like”. Mature ESG DD practitioners are making a strong link between their overarching corporate sustainability strategy and their ESG DD procedures. They are connecting their ESG DD findings to post- closing actions. And they are focused on value creation opportunities (i.e., “upsides”) rather than just mitigation of risks.

The immediate priorities for dealmakers are becoming clear. First, dealmakers need to understand their company’s ESG strategy and identify the areas that are truly material. This can help them break through the complexity caused by the breadth of the term ‘ESG’. Second, they need to develop a “blueprint” for their ESG DD approach, both in terms of intellectual framework as well as in terms of organization (dedicated workstream vs. fragmented workstream model). This will require ensuring proper budgets and resources are in place to deliver on these objectives.

Help is at hand. While the field of ESG DD continues to evolve, practitioners should look to leaders and other relatively more mature sectors to uncover new ideas and approaches to ESG DD. Dealmakers may also want to consider leveraging the experience of outside advisors and practitioners to not only ensure a robust DD process, but also to help share insights and knowledge as the ESG DD framework.